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The Pros and Cons of Buying a Commercial Property

There are over 5.7 million commercial buildings in the United States. Between 2003 and 2012, the number of commercial buildings increased by 14%. When considering the booming commercial real estate market, it makes sense why many people would want to get a piece of the action.

Whether you are a business owner or just a real estate investor, buying a commercial property can be a worthwhile investment. But that doesn’t mean that there aren’t risks involved as well.

Read on, and we’ll walk you through the various pros and cons of buying a commercial property.

Pros

For better or worse, commercial property investing is a much different ball game than residential investing. That being said, investing in commercial real estate is an excellent way to build equity and achieve a passive income.

Income

Compared to owning residential property, you can earn a significantly higher ROI with commercial real estate. You can expect an annual return of the purchase price of a commercial property to be between 6% and 12%.

Single-family homes will usually only net you between 1% and 4%.

Trip Net Leases

Many commercial properties will involve a net-net-net or “triple net” lease. With this sort of lease, it is the tenant who is responsible for ongoing property costs such as insurance, taxes, maintenance, in addition to them paying utilities and rent.

Businesses, especially large ones like Starbucks or Best Buy, will do this so that they can have better control over the operation of their stores. The only expense you actually have to pay is the mortgage. 

This allows you to have a much more passive relationship with the property while still receiving your income. 

Maintained Quality

The cleanliness and overall presentation of a storefront can directly affect a company’s sales. Because of this, business owners have a vested interest in keeping the property well maintained and functional.

This means that as the property owner, you are less likely to deal with tenants who will let their property fall into a mess. This will help maintain the quality of your investment and will save you on cleaning costs when you are seeking a new tenant.

Objective Evaluations

When evaluating the price of a commercial property, you can get a look at the income statement of the current owner. This will help you determine what the price should be. 

If the seller is using knowledgable and experienced commercial property brokers, the asking price should be at a number where an investor could earn that area’s prevailing cap rate.

This differs from residential real estate, where asking prices can get much more emotional.

Cons

It is generally agreed that buying a commercial property is a much more risky and complicated process than buying residential real estate. Below, we will discuss the main reasons for this.

Commercial Properties Are Sensitive to the Economy

When the overall economic conditions are rough, residential property owners can likely expect a lower ROI than they were hoping for. Commercial properties can be significantly more affected by an economic downturn.

Everybody needs a place to live. But when a recession hits, not every business can survive. Many small business owners may choose to work from home instead of paying rent. Or a business may just close entirely.

If it seems like a recession is on the horizon, there are certain things you can do to prepare your property.

Empty Properties Take Longer to Fill

Commercial properties typically get longer leases than residential ones. Unfortunately, it also usually takes a long time to actually find a tenant for a commercial building.

Because your property is meant for a business, it takes longer to find a business that is best suited for that property. As you continue to look for a tenant, you are still expected to pay the mortgage, taxes, and all other related costs.

Writing the lease can be a pretty complicated process as well. You need to understand the differences between triple net and gross leases as well as market cap rates. Plus, you need to take into account the local laws which can affect how your lease is written.

Old Commercial Properties are Threatened by Newer Ones

If you invest in an older commercial property, you are going to have a tough time competing with new and upgraded ones. Tenants are almost always more interested in modern buildings and may be reluctant to check out old ones.

Residential property owners experience the same problem but upgrading a commercial space can easily be a more expensive endeavor. As new properties continue to be built, the threat of losing tenants also continues to rise. 

Financing Is More Complicated

It is relatively easy to get financing for residential real estate. This is not the case for commercial. 

With commercial, the loan amount will be gradually paid off in less than 30 years. It is often followed by a balloon payment mode. The investor needs to pay off the loan by the time the balloon payment is due.

A lot of investors intend to refinance when the balloon payment is due. Unfortunately, if the market turns downward, this can make refinancing very difficult.

Is Buying a Commercial Property Right for You?

Buying a commercial property isn’t for the faint of heart. That being said, it can be an excellent way to generate wealth.

We suggest that you review the above information. Once you feel informed enough, decide if getting involved with commercial real estate is right for you.

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